FIN622 Assignment # 1 Solution

Corporate Finance “Fin622”
Assignment No.1
Solution:
Part (A)
We know that for a project with equal annual receipts:
For project A:
PPA = I0 / Ct
= 57,000 / 20,000
= 2.85 Years
For project B:
Year
Cash inflow (CFi)
Cumulative cash inflow
1
Rs. 22,000
22,000
2
20,000
42,000
3
18,000
60,000
4
16,000
76,000
The pay back would be between second and third year.
The amount of money recovered the end of second year
= 42,000 (22,000 + 20,000)
Sum of money to be recovered at the end of third year
= 54,000 – 42,000
= 12,000
PPB = 2 + 12,000
18,000
= 2.67 Years
Part (B)
NPV for project A:
NPVA = − Io +PV (CF1) + PV (CF2) + PV (CF3) + PV (CF4) + ...+ ∞
= - 57,000 + (20,000 x PVIFA14%,4years)
= -57,000 + (20,000 x 2.914)
= -57,000 + 58280
= 1280
NPV for project B:
NPVB will be calculated as shown in following table.
Year
Cash inflows(CFi)
PVIF14%,i
Present value
1
Rs. 22,000
0.877
19294
2
20,000
0.769
15380
3
18,000
0.675
12150
4
16,000
0.592
9472
Present value of all cash inflows
56296
Less: Initial investment
54,000
Net present value (NPV)
2,296
Part (C)
Summarizing the information from above calculations in following table.
Approach
A
B
Pay back period
2.85
2.67
Net present value
1,280
2,296
The Project B should be selected.
Reasons:
• The project B possess a lesser payback period as compared to Project A.
• NPV for project B is greater than Project A.